Home Ownership

How to Get a Loan to Build a House

: Family sitting in living room reviewing building plans for the house that they are building

Instead of buying an existing house for your next home, have you considered building? There can be many advantages to owning a brand-new house, such as higher energy efficiency, lower repair costs, and the opportunity to customize many features. The first step is determining how to get a loan to build.

Starting the Process of a New Construction Loan

The initial steps of obtaining a construction loan are similar to buying an existing house:

Meet with a lender to get pre-approved for the amount you can afford.
Develop your wish list, including locations and features.
Visit new home communities and builders in your selected price range. An experienced real estate agent can be a valuable resource.

Your next financing steps will depend on whether you have decided to buy a production or custom home.

Buying Within a Development

If you buy from a builder who is constructing multiple houses within a specific development, a practice called production building, the financing process will be very similar to buying an existing house. In most cases, the builder can arrange financing for you—but make sure it is a competitive offering.

The main difference from other loans is that you apply for your loan when you sign the contract with the builder, but you don’t lock in the loan terms until the property is complete.

Buying a Custom-Built Home

If you’re having a house built on your own lot with your own design, you have many more financing options, but there are more steps involved. Unless you are paying in cash, you will need to arrange for a construction loan. These are not as widely available as regular home loans, so you may have to shop around.

Some lenders provide a one-step loan that is interest only while the house is being built and then converts to a mortgage once construction is finished. The advantage is that you will have to pay closing costs only once. Some lenders, however, prefer a less risky two-step process. This requires you to take out an interest-only loan for construction and then refinance into a regular mortgage when the house is completed. The short-term interest-only loan is usually at a prime-plus rate, while the later portion reflects regular mortgage interest rates.

Strong Credit Requirements

Construction loans are considered higher risk. You will need strong credit and a down payment of 20% to 25%. The specific down payment requirement is determined by the cost of the land and planned construction. If you already own the land, you can use it as equity for your construction loan.

Your lender will check the credit and credentials of your builder as well. Drawdowns on the funds are usually at prescribed completion points, requiring that inspectors approve the progress.

Other Funding Sources for New Construction

If you have equity in your current home, your lender may offer a bridge loan to use while your new home is being built and you’re waiting for your current one to sell. This can be an expensive, somewhat risky situation since you’re planning on your home to sell, but it can help you get through a timing squeeze.

Another approach is to sell your current home and rent a temporary home while waiting for your new one to be built. While this requires you to move twice, it frees up the equity in your home to use toward your new property.

There are a few extra steps involved in financing the building of a home. When you consider all the pros and cons, you may find that the advantages of a brand-new home outweigh the complexities. Happy building!